As you know, I am concerned about the valuation of Facebook’s stock, especially post-IPO.I understand that Facebook is a great and tremendously exciting company that already has nearly a billion users and will soon have 2-3 billion users. And I understand that that could ultimately be worth a fortune.
But my point is this:
Facebook is already worth a fortune.
And Facebook’s current business simply does not support a valuation of $125 billion, or wherever the stock ends up trading after the IPO. (Some folks, like Paul Kedrosky, think the stock will close tomorrow at a valuation $150 billion. And that’s actually quite plausible, especially since a huge amount of the demand for Facebook stock is being driven by people who think it’s a great investment because they use it.)
So that means that investors who pay $125-$150 billion for Facebook today are counting on Facebook introducing new products that radically improve its business and profits.
For Facebook to actually be worth $125-$150 billion or more today, it will have to be worth, say, $300-$400 billion in a few years. Otherwise, the downside risk in ths stock simply isn’t worth taking. And to actually be worth $300-$400 billion in a few years, Facebook will have to be earning about 10X-20X as much money as it earned last year.
Because, someday, Facebook will stop being the market’s favourite “shiny new object” and will start being just another cool tech company. And when that happens, investors will probably place the same multiple on Facebook’s earnings that they place on other cool tech companies, like Apple and Google.
Apple is trading at 13X last year’s earnings.
Google is trading at 19X last year’s earnings.
Facebook will soon be trading at 100X-150X last year’s earnings.
It’s hard to be sure of anything when predicting the future, but here’s something that seems highly probable. Someday, Facebook will trade at a multiple that is similar to where Apple and Google are trading today (15X-20X earnings). The only question is “when?”
If Facebook trades at that multiple in a few years, it will have to earn $20 billion of profit to justify a $300-$400 billion valuation. That’s 20-times the amount Facebook earned last year. It’s also more than twice as much as Google earned last year. And Google is still 10X Facebook’s size. And it’s product–ads targeted to those who have explicitly expressed interest in buying the product–is arguably profoundly more valuable than Facebook’s ever will be.(Facebook’s ad space is social. It’s like hanging ads on the wall of a party. Even if the people at the party are your exact target customers, that doesn’t mean they’re going to be receptive to your ads.)
So that’s a big hill to climb.
But maybe Facebook will be the first company in history to trade at 30X-60X earnings forever. Or maybe Facebook’s earnings will grow so astonishingly fast that Facebook will actually earn $20 billion in a few years. Anything is possible.
In that vein, I just spoke to an industry insider who has seen Facebook’s forthcoming ad products and expressed enormous enthusiasm about Facebook and Facebook’s as-yet-unveiled product line.
Facebook’s product development pipeline is amazing, this insider said. And “business is booming.“
The insider thinks Facebok’s business is going to “pop” soon, which I interpreted as “reaccelerate.”
The insider dismissed concerns about Facebook’s ads being ineffective and the transition to mobile and so forth.
In short, the insider thinks that Facebook is just getting started.
And that’s certainly the bullish thesis.
And Facebook is indeed a great company that will grow a lot and, eventually, could justify today’s valuation.
But investors should also understand just well Facebook will have to do in the future to justify its current valuation.
If you can’t map out a way for Facebook to get to, say, $10 billion in earnings in 5 years–which would justify a valuation of about $200 billion–there’s just no way you should be comfortable investing at a $125 billion – $150 billion valuation today.
There’s a price for everything. And there’s a price at which Facebook would be an absolutely screaming back-up-the-truck “buy.” But the price you’re going to have to pay for Facebook tomorrow is likely to be much, much higher.